First of all, let us review what payback period is. It is usually referred as the amount of time it takes for an investment to recover its initial cost. Basically, it is the length of time an investment finally reaches a break-even point. Now the difference between the normal payback period and the discounted payback period is that, the latter is a modified version of the former which considers the time value of money. As you already know, the normal payback period doesn’t account the time value of money, hence, the resulting value may not be as accurate as the actual.
Though both metrics can be considered to be used to calculate the amount of time a project will take to generate enough cash flow that covers the initial cost of the project, both are feasible tools used to evaluate the profitability and feasibility of an investment.
It is very easy to calculate the discounted payback period. The first thing you need to do is simply discount the projected cash flows each end year of the project. Then the next thing to do is to subtract the discounted cash flows from the initial cost figure resulting with the discounted payback period. Basically, after calculating all the discounted cash flows for each period of the project, you will need to subtract each discounted figure from the initial investment each period until you reach zero.
To better understand how to calculate the discounted payback period manually, you can refer to the formula: Discounted Payback Period = A + (B/C), where A stands for the last period with negative cumulative discounted cash flow; B stands for the absolute value of the last negative cumulative discounted cash flow at the end of period A; lastly C which stands for the total discounted cash flow received during the period after A.
If you want to know more about how to calculate the discounted payback period and how the discounted payback period formula works, you can read more here: Payback Period. You will also find references and tools such as industry-specific financial model templates which includes the calculation of payback period and other profitability and feasibility metrics that you can download.
Get more financial model templates that are industry-specific for other use cases too such as valuation, break-even analysis, three statement model, and many more that you can use as a base to start your very own financial model at eFinancialModels!